Chapter 4 Automated Clearing House (ACH) Transactions

• Jurisdiction: United States

Chapter 4 Automated Clearing House (ACH) Transactions

Automated clearing house (ACH) payments are electronic transfers made through a national clearinghouse network known as the ACH Network. The ACH Network is managed by the Electronic Payments Association (NACHA), a nonprofit association whose members are financial institutions, regional payment associations and others. The ACH Network connects all of the financial institutions in the U.S.³⁹ In 2017, the ACH Network handled transactions in the U.S. totaling more than $21.4 billion.⁴⁰ While ACH payments are particularly well-suited for regularly recurring obligations that are constant in amount, such as payroll or lease payments, they are increasing in popularity for one-off transactions. The rights of the parties to ACH transactions are governed by the NACHA Operating Rules and Guidelines, Uniform Commercial Code Article 4 (check transactions) and Article 4A (funds transfers), various federal laws and regulations, and contractual agreements among the numerous parties.

A. Demystifying ACH Transactions

1. Terminology

The first step to understanding how ACH transactions work is mastering some basic terminology.

Originator: the party who initiates or originates the transaction by making an instruction. The originator can initiate either a credit (i.e., "pushing" funds to another account, or crediting another account) or a debit (i.e., "pulling" funds from another account into its account, or debiting another account). Rather than thinking of the originator as either a payor or a payee, it is helpful to remember that the originator is simply the party who originates the transaction.

Receiver: the party who is the ultimate recipient of the transaction initiated by the originator. The receiver's account is either credited (when the originator "pushes" funds into the receiver's account) or debited (when the originator "pulls" money out of the receiver's account). Because a common definition of "receiver" is "someone who receives something," it is tempting to assume that the receiver is the one who receives the funds.⁴¹ However, in these transactions the receiver of an ACH transaction can receive either a credit or a debit. The receiver is better remembered as the party who ultimately receives the transaction (either debit or credit).

Originating Depository Financial Institution (ODFI): the bank in which the originator's account is located.

Receiving Depository Financial Institution (RDFI): the bank in which the receiver's account is located.

ACH Operator: The ACH operator is like a black box to which all of the nation's banks are connected, directly or indirectly.⁴² Instructions are sent by the ODFI to the ACH operator, then the instructions get delivered to the RDFI. The ACH operator keeps a running tally of each institution's instructions (i.e., it aggregates the debits and credits). At the end of each day, the ACH operator and each of the banks settle up. Each bank either receives from, or pays to, the ACH operator the amount of funds necessary to zero out all of its net credits or debits. There are two ACH operators: the Federal Reserve and the Automated Clearing House.

2. An ACH Transaction, Step by Step

Each transaction begins with the originator, who either wants to pay money to, or collect money from, someone else. The originator gives its instructions (pay or pull) to the ODFI. The ODFI makes an entry (an ACH entry) into the system on behalf of its customer. If the originator's instruction is to debit (pull from) the receiver's account, the ODFI credits the originator's account. In either case, the receiver has already agreed to serve in that role and allow its accounts to be manipulated by an ACH transaction.

The ODFI continues throughout the day to enter instructions from other originators, and at predetermined intervals, the ODFI sends batches of ACH entries to the ACH operator. Te ACH operator sorts through the entries that it receives and provides each RDFI with the entries that pertain to it. Te RDFI then either accepts each instruction or returns it. The RDFI has a brief period of time during which it can make a return; if it misses the deadline (sometimes called the "midnight deadline"), then the transaction will be treated as if it were accepted.

Each institution's ACH entries are aggregated daily by the ACH operator, resulting in a net (i.e., each institution either had more funds outgoing than incoming, or vice versa). Each institution then settles its net by either paying the net to, or receiving the net from, the ACH operator. By aggregating and netting their financial transactions with the ACH operator, the institutions avoid the necessity of making millions of individual transfers each day.⁴³

The RDFI either debits (if the debit instruction has not been returned, discussed below) or credits (to reflect payment from the Originator) each receiver's account in accordance with the entries that have been transmitted to it by the ACH operator. The funds credited to the receiver's account will...